In
finance, an abnormal return is the difference between the actual
return
Return may refer to:
In business, economics, and finance
* Return on investment (ROI), the financial gain after an expense.
* Rate of return, the financial term for the profit or loss derived from an investment
* Tax return, a blank document o ...
of a
security" \n\n\nsecurity.txt is a proposed standard for websites' security information that is meant to allow security researchers to easily report security vulnerabilities. The standard prescribes a text file called \"security.txt\" in the well known locat ...
and the
expected return
The expected return (or expected gain) on a financial investment is the expected value of its return (of the profit on the investment). It is a measure of the center of the distribution of the random variable that is the return. It is calculated ...
. Abnormal returns are sometimes triggered by "events." Events can include
merger
Mergers and acquisitions (M&A) are business transactions in which the ownership of companies, other business organizations, or their operating units are transferred to or consolidated with another company or business organization. As an aspect ...
s,
dividend
A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-inv ...
announcements, company earning announcements, interest rate increases,
lawsuit
-
A lawsuit is a proceeding by a party or parties against another in the civil court of law. The archaic term "suit in law" is found in only a small number of laws still in effect today. The term "lawsuit" is used in reference to a civil actio ...
s, etc. all of which can contribute to an abnormal return. Events in finance can typically be classified as information or occurrences that have not already been priced by the
market.
Stock market
In
stock market trading, abnormal returns are the differences between a single stock or portfolio's performance and the expected return over a set period of time. Usually a broad index, such as the
S&P 500
The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices. As of ...
or a national index like the
Nikkei 225
The Nikkei 225, or , more commonly called the ''Nikkei'' or the ''Nikkei index'' (), is a stock market index for the Tokyo Stock Exchange (TSE). It has been calculated daily by the ''Nihon Keizai Shimbun'' (''The Nikkei'') newspaper since 1950. ...
, is used as a benchmark to determine the expected return. For example, if a stock increased by 5% because of some news that affected the stock price, but the average market only increased by 3% and the stock has a
beta
Beta (, ; uppercase , lowercase , or cursive ; grc, βῆτα, bē̂ta or ell, βήτα, víta) is the second letter of the Greek alphabet. In the system of Greek numerals, it has a value of 2. In Modern Greek, it represents the voiced labi ...
of 1, then the abnormal return was 2% (5% - 3% = 2%). If the market average performs better (after adjusting for beta) than the individual stock, then the abnormal return will be negative.
:
Calculation
The calculation formula for the abnormal returns is as follows:
where:
AR
it - abnormal return for firm i on day t
R
it - actual return for firm i on day t
E(R
it) – expected return for firm i on day t
A common practice is to standardise the abnormal returns with the use of the following formula:
where:
SAR
it - standardised abnormal returns
SD
it – standard deviation of the abnormal returns
The SD
it is calculated with the use of the following formula:
where:
S
i2 – the residual variance for firm i,
R
mt – the return on the stock market index on day t,
R
m – the average return from the market portfolio in the estimation period,
T – the numbers of days in the estimation period.
Cumulative abnormal return
Cumulative abnormal return, or CAR, is the sum of all abnormal returns. Cumulative Abnormal Returns are usually calculated over small windows, often only days. This is because evidence has shown that compounding daily abnormal returns can create bias in the results.
See also
*
Market value
Market value or OMV (Open Market Valuation) is the price at which an asset would trade in a competitive auction setting. Market value is often used interchangeably with ''open market value'', ''fair value'' or ''fair market value'', although the ...
*
Rate of return
In finance, return is a profit on an investment. It comprises any change in value of the investment, and/or cash flows (or securities, or other investments) which the investor receives from that investment, such as interest payments, coupons ...
References
{{DEFAULTSORT:Abnormal Return
Equity securities
Stock market